Why Is The Stock Market So Expensive?
It seems like every other week there is an article published about this topic. So, are current stock prices reasonable or not? We believe there are two major reasons why the U.S. stock market is setting records. Let’s take a look at each:
First, the price of the market is a direct representation of the value of the companies represented. Companies’ share prices are highly dependent on profitability, dividend payouts, and expectations for future growth. Broadly speaking, companies have increased their profitability and have maintained this pace for the past year or so.
For background, the year over year change in earnings for a specific subset of US and International companies, that we as part of our investment research process, shows the following:
Second Quarter 2016: -5.6%
Third Quarter 2016: +6.5%
Fourth Quarter 2016: +10.3%
First Quarter 2017: +15.7%
So with the profits of companies in our data set rising strongly it certainly makes sense that the value of those companies would also rise. The perception of the professional financial community is that as a whole, the companies that make up our publicly traded marketplace are healthy now, and are getting healthier over time.
The next reason for the U.S. stock market to be so high is what we call the global factor. We live in a truly global marketplace for investing, and capital is mobile; it can flow to where the best opportunities are. The U.S. stock market is only one of many choices. When investors scan the options and opportunity to engage their capital they look at everything globally. Once again, U.S. markets attract capital from all over the world. When U.S. markets are compared with other markets around the world, the U.S. is often viewed as the best combination of stability and growth compared with other large blocs such as China, European Union, Japan, United Kingdom, Middle East, Pacific Rim, South America, etc.
It is Important to look at the entire spectrum of investment choices and then choose the best from all the alternatives. We believe the U.S. continues to be relatively more attractive as a magnet for worldwide capital flows.
WHAT TO WATCH FOR
Financial markets are dynamic, and they change quickly. We will be looking closely at the complete Second Quarter 2017 data, which will be available in a few weeks. We are expecting another strong quarter, but not as strong as the previous quarter. Will that be a sign that the strengthening profitability of U.S. companies is starting to slow, or is that just a temporary blip? Did the rise in interest rates by the U.S. Federal Reserve affect earnings so soon? How will central bank policies in the U.S., Europe, Japan, China, etc. affect the financial markets? The number one discussion point at our Investment Committee every week is to evaluate how long the legs to this surge of earnings are, and when a slowdown occurs will it be a modest return to normal or a period of increased volatility and uncertainty.
Have any questions or concerns? Talk to one of our advisors today!